Paper 14: Stablecoins
Paper 14: Stablecoins
Are your stablecoins really "stable"?
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Whilst you may not have got into cryptocurrencies to hold dollars, it is very important to understand what your “stable” digital asset options are.
They are certainly not all the same - and some of them are considered to be significantly more “stable” than others.
What is a stablecoin?
A stablecoin is a digital currency which is pegged to a reserve asset like the U.S. dollar (or something else “stable”).
The point of a stablecoin is to provide some stability to your digital coins. Most cryptocurrencies (even the “main ones” like BTC and ETH) are pretty volatile, so it is very useful to be able to have some digital coins which are not constantly going up and down in value.
This traditional, predictable stability combined with the flexibility of a digital asset makes stablecoins increasingly attractive to store and transfer value in a digital-first world.
What are the other benefits of a stablecoin?
No bank account required - You can send and receive stablecoins without a bank account
Earn - It’s possible to earn higher rates of interest on stablecoins than your money in a normal bank
Ease of transfer - You can send huge quantities of stablecoins across borders for significantly lower fees than a similar bank transfer would command
How are stablecoins made “stable”?
Stablecoins are made stable in different ways:
(i) Fiat-backed - This method means that for every unit of a stable coin issued, there should exist one dollar or asset with equivalent fair value held in an account somewhere to ensure your stablecoin is “backed” (ie. 1 stablecoin = $1)
(ii) Crypto-backed - This method means that for every unit of a stable coin issued, there should exist more than one dollar worth of crypto to back the stablecoin. The reason why crypto-backed stablecoins are over-collateralised (meaning that there is more crypto held than the dollars for which they back) is because crypto is much more volatile than other assets. Thus, overcollaterlisation provides a buffer so that if the value of crypto drops sharply, the stablecoin is still likely to always be backed by enough crypto.
(iii) Algorithm backed - algorithms can be used to create price stability for stablecoins in the same way that a central bank might control money supply to maintain valuations of currency.
The way it works is that algorithms / smart contracts manage the supply of tokens in circulation: if the market price of the stablecoin falls below the price of the fiat currency it tracks, the algorithm will reduce the number of stablecoins in circulation to adjust the stablecoin value up; if the market price of the stablecoin increases above the price of the fiat currency it tracks, the algorithm will increase the number of stablecoins in circulation to make the stablecoin value go down.
What are the most prominent stablecoins and what are their similarities and differences? Is there a “best” stablecoin?
To be clear, I am not an expert in this. But from what I have researched I have learned the following and become aware of a few prevailing opinions:
USDC - this coin is a partnership between Circle and Coinbase - it’s pretty well respected. It is backed 1:1 by real US dollars, which are held in real bank accounts.
USDT - this coin is pretty popular and has a lot of liquidity, but it isn’t necessarily as clear which assets are backing it. It appears that it is a combination of fiat and commodities which back the coin.
DAI - maintained and regulated by Maker DAO. It is a crypto-backed stablecoin. The benefit of this is that it is fully “decentralised” so cannot be frozen by a centralised authority, which there is at least a chance of happening with the other two options.
Final thoughts
Demand for stablecoins is increasing.
The ability to earn a greater return on your stablecoins than your money in the bank is game-changing. In addition, it’s so quick and easy to do business with people across the world (speaking from experience as someone who contracts regularly with people in the US and elsewhere).
As such, I expect to see many governments issue CBDCs (Central Bank Digital Currencies) soon. The impact of these are TBC.
In the meantime, I like USDC and a bit of DAI exposure for my stablecoins.
As with everything in this space, things can turn quickly on regulatory news and changes in the market.
Please DYOR and keep up to date with the latest news.
Have a great day,
B
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Disclaimer: The content covered in this newsletter is not to be considered as investment advice. It is for informational and educational purposes only.
I hold some of the NFTs mentioned in these newsletters.